AP Microeconomics Unit 3

The Law of Diminishing Marginal Returns

As variable resources increase, the additional output produced from each unit of input eventually decreases.

Short Run

A period in which at least 1 resource is fixed

Long Run

All resources are variable, none are fixed

Average Fixed Costs Curve Characteristics

Has a negative slope and is always decreasing, flattens out over quantity produced but will never reach zero

ATC and AVC Will Never intersect

Average Variable Costs Curve Characteristics

Starts decreasing, then when it intersects with MC, it begins increasing.

Becomes closer and closer to the ATC, but will never intersect it

Average Total Costs Curve Characteristics

Has a parabola like shape, intersects with MC at it’s lowest point (like the vertex)

Marginal Cost Curve Characteristics

Strats decreasing due to worker specialization, then like the Nike Swoosh increases again due to Law of Diminishing Marginal Utility

Intersects both ATC and AVC at their lowest points

Effects of Change in Fixed Costs (2)

AFC and ATC Change

Effects of Change in Variable Resource Costs (3)

Changes MC, AVC, and ATC

Economies of Scale

Due to mass production techniques and specialization, firms begin having lower per-unit costs

Diseconomies of Scale

Per-unit costs begin increasing as the firm becomes too big and difficult to manage

Long Run Average Cost Curve

Short Run Production Cost Curves (MC, ATC, AVC, AFC)

Accounting Profit

Looks at total revenue minus accounting (explicit) costs, does not include opportunity costs

Economic Profit

Includes opportunity costs that forms pay when using resources, as well as explicit costs

Normal Profit

Price intersects MC and ATC at the same point, with AVC still below ATC

Short-Run Profit Maximization Formula

Firms should continue to produce until the additional revenue from each new output equals the additional cost, in other words, when MR = MC

Shutdown

Is temporary, so firms still have to pay fixed costs

Shutdown Rule

A firm should continue to produce as long as price per unit is above AVC (the minimum of AVC). This means that at least loss is less than the fixed cost

When the point on the MC that is being produced at is above the minimum of the AVC

Short Run Supply Curve

Is equal to the MC line from the point where it intersects the minimum of the AVC and onwardW

When would other firms enter the market in the long-run?

If firms are making profit, then other firms have an incentive to enter

High Barrier to Entry Market Characteristics

Have less competition, and individual firms make more profit

Low Barrier to Entry Markets

Have more competition, and individual firms make less profit

Marginal Revenue Curve

If price is constant, then MR is a horizontal line at the market price

Four Market Structures

Perfect competition, monopolistic competition, oligopoly, monopoly

Characteristics of Perfect Competition

Lots of small firms that sell identical products

Low barriers to enter and exit

Sellers have no need to advertise goods, and they are price-takers with the industry setting the price

Characteristics of a Monopoly

One firm is the market, they have a unqiue product with no substitutes

There are high barriers to entry

The monopolies are the price setters

Perfect Competition Market Supply and Demand Graph

A normal supply and demand curve (X shape)

Perfect Competition Individual Firm Supply and Demand Graph

MR=D=AR=P horizontal line

Where MC intersects MR is where quantity is produced

Whether ATC is below, touching, or above at that line determines what kind of profit the firm is earning

Long Run Equilibrium

No firm has any reason to enter or leave becuaes they are making normal profit (earning zero economic profit)

ATC touches the point where MC=MR

Firms are allocatively and productively efficientPr

Productive Efficiency

Producing at the lowest possible cost (the minimum of the ATC)

Types of Barriers to Entry

1. Economies of scale (natural monopoly, only one company can utilize resources without needing to shutdown)
   
   2. Superior Technology
   
   3. Geography or Ownership of Raw Materials
   
   4. Government Created Barriers (ex. patents)

Allocatively Efficient

In the short-run, perfectly competitive firms are always allocatively efficient

This means they are producing exactly what society wants, when P = MC

Oligopolies

There are less than 10 large producers and high barriers to entry

The firms control the price

Firms must worry about the decisions of their competitors, there is mutual interdependenceMon

Monopolistic Competition

There is a relatively large number of sellers with differentiated products

Firms have some control over price, and there is a lot of advertisign competition

Low barriers to entry

Graph when Profitable Market Moves Short Run → Long Run

Firms enter the market and supply shifts to the right

This causes price to decrease and quantity to increase, creating a new equilibrium price that firms must accept

This new price decreases quantity sold and lowers price, ending up at zero economic profit

Graph when Unprofitable Market Moves Short Run → Long Run

Firms leave the market so the supply curve shifts to the left

This causes the price to increase and quantity to decrease, creating a new and higher equilibrium price

For firms this leads to higher quantity produced and higher price, ending up at zero economic profit

Constant Cost Industry

When going from the long run to the long run, new firms entering the market does not change input prices

Long-run average cost stays the same and firms keep making normal profit, maintaing allocative and productive efficiency

Long-run market supply (connecting the two equilibriums) is perfectly horizontal

Increasing Cost Industry

The entry of new firms raises input prices, causing long-run ATC to increase

The long run supply (connecting 2 equilibriums) is upward sloping, with the market price not returning back down